The cost of hedging for a global aggregate bond ETF holding bonds in multiple currencies is about the sum of the interest rate differentials across the currencies weighted by the proportion of exposure to each currency.I was wondering how much of the growth would be deteriorated by the cost of hedging.
As a formula: Total Hedging Cost of an EUR Hedged bond ETF = Sum over i (weight of currency i * (interest rate in currency i - interest rate in EUR))
I use the Vanguard Global Aggregate Bond UCITS ETF EUR Hedged as an example for currency weights.
So if you have the ECB deposit rate of 3% and the following table of weights and deposit rates of the other major currencies:
USD, weight 50%, Fed Funds rate 4.58%
JPY, weight 6%, BOJ rate 0.25%
GBP, weight 4%, BOE rate 4.75%
... you can roughly calculate the cost of hedging with the formula above and the data from the table:
Total Hedging Cost of an EUR Hedged bond ETF = 0.5 * (0.048 - 0.03) + 0.06 * (0.0025 - 0.03) + 0.04 * (0.0475 - 0.03) = 0.00805 = 0.805%
If you need more accuracy you would have to know which currencies the ETF hedges exactly and their weights and their deposit rates.
The yield to maturity of the Vanguard Global Aggregate Bond UCITS ETF EUR Hedged is 3.8%.
The hedging cost brings it down to 3%.
This is exactly the ECB deposit rate.
Key take away I: The hedging cost effectively aligns yields across different currencies to the level of the base currency being hedged - in the case of a EUR Hedged bond fund, the EUR yield at the ECB deposit rate.
Key take away II: Hedging cost/gain goes in both directions: it is a a hedging cost, if ECB deposit rate is lower than currency i rate, but it is a hedging gain, if ECB deposit rate is higher than currency i rate (for example BOJ rate).
Key take away III: by hedging to EUR you not only get the lower interest rate but also the lower inflation expectation in the EUR zone compared to say USD, which has a higher inflation expectation.
Hope that makes it a bit more transparent.
Statistics: Posted by tre3sori — Tue Dec 17, 2024 11:40 am
